What is Currency Depreciation?

Currency depreciation can generally be described in two different ways. In the case of a single currency, it refers to a loss of value of a country's money over time such that it buys fewer goods on the open market than it did at a prior point in time. When comparing two currencies, the term currency depreciation refers to the loss of value in one currency such that its relative value compared to the other currency has been reduced.

The loss of value in a single currency is part of the economic condition called inflation. During an inflationary cycle, prices of goods and services rise. The offset is a devaluation of the currency used to pay for those goods and services. An increase in the cost of raw materials in manufacturing or petroleum products needed to support production can cause price increases and result in currency depreciation.

A government can cause currency depreciation by putting more money into circulation. Assuming a fixed amount of goods and services, the total amount of money increases relative to that total amount of goods and services. The result is a reduced value for each unit of the currency.

In an international setting, currencies are measured against one another through either a fixed or floating exchange system. Most countries allow their currencies to adjust against others based on market conditions in a floating exchange rate system. These exchange rates are influenced by the balance of trade between countries and other economic factors.

When one currency buys less of another than it previously did, it has depreciated. For example, if the value of country A's currency is now half of its previous value relative to country B's currency, the exported goods from country A will now cost half as much in country B. This price change can encourage consumers in country B to buy more products imported from country A. Conversely, country B's products exported to country A will cost twice as much, and consumers in country A will be less likely to purchase those products. In country A, this scenario may help to improve a trade deficit, but the opposite will be true in country B.

If the currency depreciation in country A occurs repeatedly, the confidence of consumers and other countries in the health of country A's economy can be affected. The likelihood of investment in country A can be reduced, and it may be harder for it to borrow money. Currency devaluation in country A can also lead to inflation because it is offset by increasing prices.